China prices rattle miners

Concerns over Chinese inflation, falling steel prices and a contract ­dispute have raised fears of a drop in iron ore prices that would hurt ­Australia’s big miners.

Shares in iron ore producers, from
BHP Billiton
,
Rio Tinto
and
Fortescue Metals
to the junior end, were sold off heavily yesterday – before an afternoon bounce – as fears rose that prices for Australia’s second biggest export commodity could be caught in a second global financial crisis.

The heavy sell-off followed a 4 per cent plunge in Shanghai steel futures and a contract dispute at Australia’s fifth biggest iron ore producer,
Mount Gibson
, which revived memories of an incident at the same ­company that triggered a big fall in iron ore prices.

But investors were also concerned that Chinese authorities would have to curb lending in response to a 6.5 per cent surge in the consumer price index for July – the strongest reading in three years – with implications for buyers of iron ore.

Government ministers have been using Australia’s close trade ties with China and the importance of the resources industry to soothe ­worries about how the global markets ­meltdown might affect Australia.

Trade Minister
Craig Emerson
said China’s growth would help cushion the Australian economy. “Not through good luck, but good management over 25 years, has Australia linked itself to China and that itself provides a real buffer to our economic future," he told Sky News.

Resources Minister Martin Ferguson said: “I can only reinforce that Australia is the flavour of the month from a reliable supplier’s point of view."

But iron ore market participants warned that small traders in the iron ore market are already finding it difficult to access financing needed to pay for Australian iron ore shipments, a point acknowledged by
Rio Tinto
chief executive
Tom Albanese
at last week’s annual results announcement.

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Company Profile

Major iron ore exporters Rio Tinto and
BHP Billiton
both use traders to market some of their ores into China and have signalled their intentions to increase the proportion of sales to this market.

The announcement late on Monday that two of Mount Gibson’s customers had baulked at accepting shipments recalled what has become known as Mount Gibson Day, when the refusal of Chinese customers to buy contracted tonnages precipitated a fall in iron ore prices from $US200 to $US50 a tonne in late 2008.

“This is definitely not related to what we saw in 2008," he told The Australian Financial Review, adding that the dispute with customers Shougang and APAC related to shipping schedules rather than a deliberate attempt to squeeze prices lower.

“We haven’t seen our customers walking," Mr Tonkin said.

Traders CITIC and Marubeni elected not to renew their contracts with Mount Gibson because of issues around terms and conditions but Shougang and APAC would take up these tonnages, Mr Tonkin said.

“There’s no question that there is fear in the market at the moment but I think people really need to settle down and concentrate on the fundamentals of this market," he said.

Steel futures plunged in Shanghai yesterday amid concerns about the potential for another global crisis. Rebar futures shed 2.53 per cent to close at 4853 yuan a tonne, the lowest since May.

“Mills are closely watching the rebar futures contract as a good indicator for underlying steel demand and a good price discovery mechanism for cash steel prices," ANZ Banking Group head commodity strategist Mark Pervan said.

Index prices from June to August, from which the fourth quarter’s iron ore prices will be set, have averaged $US174 a tonne. But a move away from the 40-year-old annual contract pricing to index and spot-market pricing has increased the vulnerability of iron ore miners to a fall in the price caused by economic jolts.

Analysts have also argued that long-term prices are likely to fall to about $US90 a tonne as more supply is brought on.

Mr Pervan said Chinese buyers were sourcing more local ores to maintain their thinning margins, with implications for higher priced exports from Australia. “A persistent discount for domestic iron ore prices versus international prices since the start of the year has created a much stronger appetite for local iron ore supply," he said.

An executive involved in raw material procurement at China’s seventh biggest steelmaker, Maanshan Iron and Steel, told the Financial Review that smaller players in the iron ore market were finding it difficult.

“Small business has a financial problem, it is harder and harder to get money," he said.

But unlike during the global financial crisis, the Chinese government was still allowing the flow of capital to bigger, state-owned companies.

“The government has a different attitude according to the type of business," he said. “The Chinese government has the power to control where the money goes."

This is keeping a firm floor underneath iron ore prices for the time being as competition among Chinese steelmakers prevents them from cutting their production despite falling margins.

“We have to maintain output even though we’re on the edge of breaking even," the Maanshan executive said.

“Every mill has its own customers and we need to keep them so we can’t cut our production. But we won’t increase our output."

A return to long-term prices in iron ore would have a huge effect on earnings at the iron ore producers that are investing billions of dollars to expand production to take advantage of the record prices on offer.

Merrill Lynch analyst Peter O’Connor said a return to long-term commodity prices, with iron ore at $US80 a tonne, would leave Rio Tinto at a distinct disadvantage compared with BHP Billiton because of its reliance on the steelmaking ingredient relative to other commodities.

“The stand out companies and commodities reflect segments in which the long term price deck is greater than, or nearly equal to, the current price deck i.e. minimal downside on a net present value basis, or in terms of coal modest upside," Mr O’Connor said.

“In BHP’s case, more oil and gas and less bulk commodities is a benefit."

Shares in BHP and Rio are down by more than 10 per cent for the past five days and 17 per cent for the year to date because of concerns over the implications of debt problems in Europe and the United States for commodity demand.

They were sold heavily again yesterday with BHP trading as low as $34.81 before bouncing to finish 45¢ higher for the day at $37.05.

Rio, which earns nearly three quarters of its profits from iron ore, traded as low as $63.85, but finished the day $1.11 higher at $69.74.

Shanghai-based Macquarie commodities analyst Graeme Train said some small traders were already exiting the market, as a lack of volatility in prices meant traders had to take larger bets to make money out of the iron ore market.

“Trading is becoming a hugely capital intensive business," he said.

“The balance between risk and reward is providing limited incentives for the small end of the market."

But Mr Train said big commodity trading houses with strong access to capital were stepping in to fill the void, and this was keeping prices strong. “You’ve seen Trafigura and Glencore really increasing their presence," he said.

“These guys can access the financing and need to really churn huge ­volumes to make money."

Mr Train said he was confident that iron ore prices could avoid the rout plaguing other commodity markets but emphasised that China may be keen to take advantage of opportunities to buy distressed assets.